We're No Where Near The End Of The Reflation Trade That's Sending Commodity Prices Soaring

Jeff
Kleintop Analyzes and discusses international markets,
trends and events to help U.S. investors understand their
significance and financial implications. In this role,
Kleintop provides research, commentary and actionable
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NEW YORK (TheStreet) --
Egypt's longstanding president, Hosni Mubarak, stepped down Friday, Feb. 11,
2011 after 18 days of widespread protests. The turmoil and
change in leadership in Egypt meant little for most stock and
bond markets. Oil prices fell despite the potential disruption to
oil transport and the risk of a spread of the unrest to oil
producing neighbors. In 1971, Pete Townsend wrote one of The
Who's biggest hits: Won't Get Fooled Again. Forty years
later, his take on the lack of any real change resulting from
revolution could be applied to the events that have transpired in
Egypt.

Far from a revolution, for investors the events mark a minor
evolutionary shift in Egypt and the region. Since a military coup
in 1952, all of Egypt's presidents have been military leaders.
The military is the most central institution in all of Egypt.
Like his predecessors, Nasser and Sadat, Mubarak served as
President at the will of the military. The military was in charge
during Mubarak's 30 years as President, they were in charge
during the 18 days of protests, and they remain in charge now.
The demonstrators are cheering, cleaning up, and going home. The
military maintained the support of the people. Any elections are
likely to involve candidates that are de facto selected by the
military.

The military stated over the weekend of Feb. 12-13, 2011 that it
will abide by all the former treaties, including the 1979 peace
agreement with Israel. This is a big part of restoring normal
diplomatic relations with the United States and other
benefactors. Internally, the army may declare martial law to get
everyone off the streets and back to work in short order. They
may also attempt to undermine the popular Muslim Brotherhood
political opposition group by invoking fears of radical Islamists
having entered the country during the chaos (former Egyptian
president Sadat was assassinated by Islamists). The military is
working as rapidly as possible to return things to normal both
externally and internally.

Markets have shown little reaction as investors watched to see if
real change was coming and if the seeds of revolution were
spreading around the region. Egypt provided an example of the
unrest that can be fueled by rising food prices. Major importers
of food and energy, such as China and India, have already have
seen a negative impact on their markets. Social stability could
also begin to unravel if soaring food and energy prices are not
addressed in emerging market countries where
they make up a large portion of consumer spending. The theme of
reflation is becoming a dominant one for 2011 and may in fact be
the true revolution taking place for investors as it defines the
performance of all markets so far this year.

The geopolitical events in Egypt had the potential to turn
investors' attention back to concerns about the durability of
global economic growth that prevailed last summer. Instead,
investors appear to be less worried about growth retreating and
are starting to differentiate their investing based on prospects
for reflation and rising interest rates. What seemed to be a
world locked into one unified global business cycle a year ago is
becoming more and more decoupled as each market classified by
size, country, and sector show differing reactions to the return
of inflation and the rise in interest rates.

TheStreet

Stocks and bonds have followed different paths with the
S&P 500 up 6% and the Barclays Aggregate Bond Index down
1% year-to-date. An improving growth outlook and the risk
that rising food and energy prices will spread into other
goods and services have pushed up long-term bond yields to
the highest levels in almost a year.

The impact of rising interest rates can also be seen in
smaller companies, which generally have a greater dependence
upon favorable borrowing conditions, as they have
underperformed their Large Cap peers this year after
generally outperforming since the market low in March 2009.

When prices reflate, commodity producers are typically
beneficiaries. Not surprisingly, the best performing sector
of the stock market this year is Energy. This year's worst
performing sector is Consumer Staples, where companies face
the high cost of food and energy inflation as inputs to their
products. Also, the most interest-rate-sensitive stock market
sectors, telecommunication services and utilities, are among
the worst performers this year as rates have risen.

Emerging Markets have been underperforming developed markets
this year for the first time in quite some time. Reflation
has been more prevalent and problematic in the Emerging
Markets. Rising inflation, mainly food and energy prices,
have been spurring unrest in a number of emerging market
countries such as Egypt, central bank rate hikes in countries
such as China, and a booming economy in places like Brazil
are pushing up interest rates. The MSCI Emerging Markets
Index is down 5% this year, while the MSCI EAFE and S&P
500 Indexes that represent developed markets are up 4% and
+6%, respectively.

Even within the Emerging Markets the reactions to the return
of inflation have been different. The stock markets in those
Emerging Market countries that benefit from rising prices
(oil and food exporters) are faring well this year, such as
Russia (+7%), Nigeria (+7%), and Iceland (+6%). While some
Emerging Market commodity importers have suffered, including
India (-15%) and Brazil (-5%).

The theme of reflation is defining the relative performance of
all markets so far this year. We expect reflation to remain a key
theme for all of 2011. This is a major change from 2010 and one
that investors are more likely to be impacted by than the
attention grabbing change in leadership in Egypt.

There will be much discussion in the coming days and weeks about
who may become the new Egyptian president. However, as has been
the case during transitions in Egypt over the past 60 years of
military rule, the military is an institution that transcends the
individual. Certainly, there will be a new president. But, just
like The Who's Roger Daltrey sang, "Meet the new boss. Same as
the old boss."